Monday, August 22, 2011

Texas and the Fallacy of Composition

As the debate over Texas heats up I become increasingly unconvinced that Texas shows a way forward for the US.  Douthat's column this morning finally inspired me to comment on it.

First of all, the composition of the employment picture shows a great deal of job growth is due to the simple effects of growth, such as government and health care.  Resisting sharp cuts to government, which is very unlike the picture in most other states, definitely helped this situation.  Oil and gas played a role in bringing in high wage jobs more high paid jobs, more supporting jobs in other sectors.  Then there is the migration picture, which seems to be driven in large part by a reputation as a job creator, which, in times like these, becomes a self-fulfilling prophecy as more people move in bringing skills and talents with them.   Avoiding the housing bust also prevented a downward spiral from developing.

So far, the picture is basically a virtuous circle of what most left leaning Keynesians say we should have been doing.  Not cutting government, supporting high wage sectors (in the case of Texas intervention wasn't required, but many states with abundant natural resources have enjoyed this prop, though they lack some of Texas' other characteristics),  and encouraging migration all help to create a positive spiral, resisting the housing bust prevented the spiral from being broken.

Of course, this positive spiral was reinforced by Texas' low cost.  But there is no reason to think the advantages of being low cost are relative to an absolute scale, rather the advantage comes form being low cost to other options.  During a downturn the comparative advantage for being low cost will be a multiple of its normal effect, if everyone is holding onto cash then cost weighs much heavier than normal.  Investors are favoring reducing downside risk over potential upside.  So Texas is strongly favored right now relative to the US.

But this is already true of the US as a whole.  We have the third lowest taxes as percent of GDP in the OECD, behind Mexico and Chile.  Compared to developed countries, the factors under the Federal government's control are already slanted towards low cost.  This relative advantage is already doing what it can do for us, factors to increase this effect, such as looser zoning requirements to lower housing costs, are under state or municipal control, not the Federal government.  In any case, even if we did try to cut, there are no competitors in close competition that we could develop a relationship comparable to Texas vs. California with.  Either that relationship already exists, in the form of say US vs. Germany, or the relative costs are so much lower that we can't compete on cost without sacrificing our standard of living (as expressed as per capita GDP).  Do we really want to reform the entire US economy to compete on costs with China, whose per capita GDP is below our poverty rate?

On the whole, I feel that trying to use the success of Texas as a model for the US is an instance of the fallacy of competition.  It works for Texas, I'm not disputing the large number of jobs there or that it is to a significant extent the result of Texas' policies, but that something works within a given system doesn't mean that it will work for Texas as a whole.  If an investor decides they want to invest in the US given current conditions a premium will be placed on low costs relative to other factors, this favors Texas.  If a business wants to keep costs low, land and labor costs favor Texas, in other times other factors may be more important but not right now.  But this doesn't mean the US as a whole can drum up business and jobs by lowering costs, there simply isn't anyone we can undercut.  Texas has hit upon exactly the right strategy for growth and job creation within the US economy, this does not mean that the same strategy will work for the US as a whole within the world economy, which has a different set of actors and conditions and requires a different strategy.


  1. You're talking about basic costs. The US still is the low cost manufacturer of many things. It really isn't clear whether business is or isn't more efficient in Texas.

  2. Doug,

    It shows how long it has been since I took accounting that I had to look up basic costs to see what it involved. The above post is probably written poorly because it's not quite what I had in mind.

    What I have in mind is more upfront costs, though with unit labor costs thrown in as well.

    Perhaps an analogy would explain it better. If we define the American system as one of high capital costs and high levels of production leading to low unit costs, with a medium cost workforce since labor is cheap relative to capital, we can then compare this to the Japanese (and similarly to the German, though a cost vs. quality factor exists that I'm ignoring) system which is also high on capital costs but also uses relatively high labor costs. The quality difference is substantial enough to reduce per unit costs under this system (this is over-simplified, Japanese lean manufacturing has more to it, it's just not necessary for this example).

    Defined this way, I see the Texas system as the Japanese system in reverse. Rather than trying to increase output through higher labor and capital costs, the Texas system emphasizes doing what is possible to lower capital (largely through cheaper land) costs without reducing capital quality and lowering labor costs (partially arbitraged by having lower costs of living, especially taxes, which raise discretionary income without leading to an increase in aggregate production, assuming that lower taxes don't translate at the aggregate into increased investment which may not be correct, in the state as a whole). This may or may not result in lower unit costs. However, it does reduce upfront costs by reducing capital costs and the ease of firing and overall low wage rate (this is also a simplification since Texas does not seem to have lower wages for high paid professions, lower labor costs are at the other end of the skill scale). I think this would be an advantage during the recession where a potential investor is more worried about the downside risks of sunk costs and is willing to trade marginally higher unit costs (or possibly quality) for less cost upfront, assuming the difference isn't that large.

    I see this not working for the US as a whole, even if it does work for Texas, for two reasons. First, I'm not sure this model has lower costs overall, which you suggested. Second, Texas is partially getting its cost advantage through arbitrage because a worker feels better off for having more disposable income, even if this may not be raising aggregate output in the state as a whole. For instance, say higher New York costs pay for more early intervention and mental health care at the state level. Workers have less disposable income, but total output may be higher if these two things are goods that create jobs and if the workers who need these two things can't pay for them out of pocket, resulting in unfilled demand in Texas that is filled in New York (as well as potentially marginally higher labor force participation and output as mentally ill workers get needed treatment and autistic children early intervention that will make the difference between them working and them being dependents, corner cases but that's what margins are about).